Reduce Financial Risk by Conducting a Stress Test for Your Small Business

How will the economy affect your business this year?

Economic conditions impact all businesses, but small businesses often feel the effect of changes sooner. Upswings in the economy mean more disposable income, which can provide a rush of new or expanded business opportunities for your firm. But dips in the economy may make it harder for you to break even, to cover payroll, or to qualify for loans that will increase your growth opportunities.

While you can’t control the economy, you can take steps to ready your small business for unexpected changes. One simple tool to consider is a stress test.

Ways to Stress Test Your Business

A stress test is a simulation to gauge your financial risk under different economic scenarios. The results can aid your financial planning and let you know where your business is at the greatest risk in the event of economic hard times.

Here are three ways to stress-test your business to stabilize it during unwanted slowdowns.

1. Solicit advice from others

Do you have an advisory board or a brain trust of reliable partners? 

SCORE, a nonprofit that is a resource partner of the U.S. Small Business Administration, offers a network of volunteers, including retired C-suite executives, who can help mentor. You can search for a SCORE mentor online or through a local chapter.

2. Plan for worst-case scenarios

One of the more effective ways to prepare for change is to make projections.

Look at what a dramatic budget crunch might do to your business or what would happen if you lost a major client or product. Evaluate how this loss would affect your business and decide how you could trim expenses or diversify your client base before this happens.

3. Review your financial cushioning

What kind of cash cushion does your business have?

While experts recommend a six-month reserve, you can probably be more specific. Look at your net “burn rate” on expenditures to identify the rate at which you spend cash holdings. Then look at your monthly budget and estimate how much money you plan to use over the next 12-15 months.

From here, you can project what kind of cushion is necessary and how long it might take you to obtain a loan or solicit an investor if money was extremely tight. Even in a worst-case scenario, having a plan in place can alleviate fear.

A Road Map For the Future

While it is wise to conduct a stress test at any time, analysts say the best seasons are typically the spring and summer because larger market crashes tend to occur in the fall.

By planning ahead now, you can make informed decisions about decreasing inventory, consolidating debt, cutting payroll, or connecting with new investors. By stress testing your business’s finances and proactively plan, you can mitigate future problems and sleep better each night.